March 22, 2006

Snow Job

Earlier this week, the Wall Street Journal reported that Treasury Secretary John Snow maintains the widening gap between high-paid and low-paid Americans reflects a labor market efficiently rewarding more-productive people. For example, Snow said, "In an aggregate sense, it reflects the marginal productivity of CEOs. Do I trust the market for CEOs to work efficiently? Yes. Until we can find a better way to compensate CEOs, I'm going to trust the marketplace."

Recall for a moment that after Paul O'Neill resigned at the end of 2002, we learned that O'Neill had a habit irritating to the Bush Cabinet: he didn't always agree with the Party. Among other things, he was not a favorite on Wall Street because O'Neill worried that the reckless fiscal policies of the Bush Administration were, well, reckless. Tax cuts were favored on Wall Street. O'Neill wasn't.

Much was said at the time that the primary reason for selecting Snow as O'Neill's replacement reflected a strong belief that Snow could and would do a better job selling the Bush tax cuts.

O'Neill must have seen his job as that of a Secretary of the Treasury of The United States of America -- a job traditionally associated with leading the effort to tackle problems of significant economic consequence. Snow, we must surmise, sees his job as a salesperson.

Skilled sales folks understand that their job is to sell. The best among them focus on communicating effectively with those whom they are trying to sell and, in doing so, sticking to pitches that are grounded in something resembling the reality -- the actual feature, function and performance-- of what they are selling. Slick sales people succeed in selling us what we come to regret because the pitch is not grounded in any kind of reality. It turns out to be hooey.

(For the moment, please note that effective sales people whose pitches are linked to reality still might exaggerate and flatter and do all kind of things that help with their effectiveness. But what they sell us is not hooey.)

So, re-read Snow's sales pitch about CEO's and efficient markets and productivity in light of these additional perspectives:

Exhibit 1: The Growth of Executive Pay by Bebchuk and Grinstein: " This paper examines both empirically and theoretically the growth of U.S. executive pay during the period 1993-2003. During this period, pay has grown much beyond the increase that could be explained by changes in firm size, performance and industry classification. Had the relationship of compensation to size, performance and industry classification remained the same in 2003 as it was in 1993, mean compensation in 2003 would have been only about half of its actual size."

Exhibit 2: Stock Options: The Backdating Games: "Following a yearlong investigation, it appears the Securities and Exchange Commission is finally beginning to crack down on companies with questionable policies governing stock-option grants.... The commission apparently became interested in the topic when academic research showed that the share price of scores of companies dropped just prior to the granting of options. The research also indicated that — surprise, surprise — share prices often rose immediately after the pricing of options."

Exhibit 3: Privileged Class: " Part of the problem, experts say, is the way executive compensation packages are determined. At public companies, the board has a compensation committee, which often is composed of peer executives from other corporations. Those committees hire compensation consultants who study what similar companies pay their executives. The committee members and the consultant have an incentive to see compensation increase, experts say. "What goes around comes around and somebody in turn is going to take care of them," said David Theobald, chief executive of Netshare, a Novato, Calif.-based Web site for people who earn more than $100,000 a year. "It's a vicious circle. ... The consultant is always going to put his best foot forward and more often than not, he's going to make it seem like it's justified. It's absolutely absurd."

Exhibit 4: Berkshire Hathaway Chairman Warren Buffett Letter to Shareholders in current Annual Report: "Too often, executive compensation in the U.S. is ridiculously out of line with performance."

Does the market for CEO pay work efficiently? As Snow says, 'yes' -- if by efficiency we mean, from the perspective of CEOs, a very predictable annual pay raise that is quite handsome.

Does the CEO pay market work effectively? That is, does it reflect 'fair pay for fair performance'?

Trackback Pings

» CEO Pay - A Systemic Failure from ChristianSarkar.com
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» Brand Is As Brand Does from Douglas K Smith
Throughout history, human beings have deployed pattern recognition skills to 'read' situations and make choices. Our most distant ancestors read the signs in things ranging from scat to stars. We use brands. Unlike them, we live in markets, not wildern... [Read More]

» Secretary Snow's Star System from Douglas K Smith
As noted last week, Secretary of the Treasury John Snow is out on the circuit hawking his boss's wares. Just ask him and he'll pull open one side of his tailored overcoat and show just how great the economy is... [Read More]

» Are CEO Compensation Markets Efficient? from Steve Shu's Blog
Having been schooled at Chicago, considered an institutional icon in espousing free market and efficient market theories, I am always initially skeptical of things that fly in the face of efficient markets. This post by Douglas Smith, however, is excel... [Read More]